Inheritance tax has an unfortunate way of cropping up at the very worst moment. Nadine Jayes of Blandy & Blandy tells how you to make the best of a bad situation
IN THIS DIFFICULT economic climate families have been increasingly relying on financial support from the older generation in order to help maintain their standard of living. In view of the potential Inheritance Tax (‘IHT’) impact of such gifts and the fact that IHT planning is a concern for many older clients, it is important that such gifts are structured in the most tax efficient way.
The basic IHT position on death is that an IHT charge will arise where individual’s estate exceeds the nil rate band, at a flat rate of 40% (subject to any exemptions or reliefs that may be available). The current IHT threshold is £325,000, which can be uplifted to £650,000 on the death of the surviving spouse since the introduction of the transferrable nil rate band provisions in October 2007. An individual’s estate will also include any gifts that they have made in the past seven years and with careful lifetime planning it is possible to minimise the potential IHT impact of such gifts.
This planning can be of particular relevance where grandparents make gifts to their grandchildren and they have various options as to how they can structure these gifts. A gift from a grandparent is more tax efficient than a gift direct from a parent to their children. In particular, the income tax anti-avoidance rules which apply to ‘parental settlements’ will not apply. Additionally, such gifts have the added benefit of generation skipping.
As a minimum measure any grandparent should ensure that they make full use of the various lifetime exemptions that are available. In particular, each grandparent should utilise their £3,000 annual exemption, make full use of the small gifts exemption of £250 per recipient and where relevant the marriage gift exemption of £2,500 per grandparent. Cleary the use of these exemptions will only have a limited IHT saving but if used to their full extent over a number of years they can be beneficial.
A more important exemption which should be fully utilised is the ‘normal expenditure out of income’ exemption, which if used correctly can achieve significant IHT savings. The main benefit of this exemption is that as such payments are exempt there is no necessity for the grandparent to survive for the requisite seven year period as the payments immediately fall out of their estate for IHT purposes. The basic requirements for the relief are that the payments are made out of income, as part of normal expenditure and do not reduce the normal standard of living.
The use of this exemption can be of particular relevance to the payment of school fees, as the regular nature of the payments fit well within the terms of the exemption. There is no quantative limit and therefore the exemption can be used to make significant gifts on an annual basis. The main criteria for the relief is that the grandparent has a suitable level of income as it is imperative that the payments are made from income and not capital.
This relief can also be used in a tax efficient way in conjunction with a lifetime trust and this is considered in further detail below. In the event that it is necessary to make a claim for the relief on death, it is important that the correct arrangements are put in place so that the appropriate evidence is available. In particular, suitable documentation should be put in place in order to prove that the terms of the relief are satisfied and a record should be kept of income and expenditure.
Any payments to a grandchild that do not fall within one of the above exemptions will be a potentially exempt transfer and will therefore be subject to IHT if the donor fails to survive for seven years. An outright gift is the most straightforward way of providing for a grandchild and has the added benefit that it can be made without limit.
However, if the grandchildren are young, such gifts may not be appropriate, especially if they are of significant value. As an alternative, a trust structure could be used to facilitate the proposed gifts. The benefit of a trust is that if the grandparents are trustees they can retain an element of control both in relation to the administration and investment of the funds and also the distribution of the trust funds. The main drawback of the creation of a trust are that any gifts to the trust will trigger an immediate IHT charge if they exceed the grandparent’s available nil rate band, currently £325,000.
However, both grandparents can make use of their individual nil rate bands enabling a gift of £650,000 per married couple. A very IHT efficient way in which a grandparent could fund and/or add to a trust would be by use of the normal expenditure out of income exemption. The exemption could be used to add funds to the trust on a regular basis, which could enable gifts of over the nil rate band to be made without triggering an unnecessary IHT charge. It is of course vitally importantly that matters are structured correctly.
Nadine Jayes is a solicitor at Blandy & Blandy